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Southeastern Asset Management: “We
welcome unpredictability”
February 20, 2017
by Robert Huebscher
Ross Glotzbach is Head of Research and a principal at Southeastern Asset
Management. He serves as a co-manager for Longleaf Partners Small-Cap
Fund and has been a research analyst at SAM since joining the company in
2004. He was an investment banking analyst at Stephens, Inc. in Little Rock
from 2003 to 2004. He holds an AB degree from Princeton University with a
major in Economics and is a Chartered Financial Analyst. Mr. Glotzbach has
been a guest lecturer at the University of Memphis, is Chairman of Memphis
Grizzlies Preparatory Charter School, and serves on the board of Ballet
Memphis.
I spoke with Ross on February 15.
In your fourth quarter 2016 shareholder letter, you allowed that the number of on-deck
companies, ones not currently owned but that potentially meet your investment criteria, is
smaller than usual. In the past, has the number of companies in the on-deck category
correlated to future returns?
There’s not been an extremely strong correlation historically except for very intense market moments
when it’s obvious that there’s a big, long list of them or when markets are high and there’s barely
anything. It has correlated to absolute returns in those cases.
It’s also a quality more than quantity thing. Even though today’s list, for example, is a bit smaller than
average, there are a good number of potentially great ones there, and we just need the right price.
We’ve prequalified them, and now we’re just patiently waiting. We have bought some companies since
quarter end that we will talk about a little later.
Also in the fourth quarter 2016 shareholder letter, you stated that values internationally are
superior to what you see in the U.S. market. Did that manifest itself in transactions in the
fourth quarter and in the first quarter of this year?
It did. We have been saying this in general for a few years; Asia and Europe are more attractive than
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the U.S. You saw it in the fourth quarter. We had three new buys in our International Fund. We had
STADA, a German drug and consumer products company that has just recently been the subject of
some merger and acquisition speculation, so it’s been a good one right off the bat.
We also bought Yum China.Yum Brands was a long-term holding for us in our Partners Fund and
global accounts for over 15 years. We’ve been watching it closely since we had sold it, and when it split
into two companies, the China business was cheaper, and we’re very happy to own that one again.
The other company we added in our international accounts was Ferrovial. It became briefly mispriced
last quarter, and we were glad to get to start adding to it again. The Partners and the Small-Cap Funds
each had one new addition in the fourth quarter, but there were more opportunities internationally.
Thus far in the first quarter of 2017, we can’t show the world yet, but we’ve found some promising
internationally headquartered investments. We continue to search the world, but find more things
outside the U.S. than in the U.S.
Thirdly, in your fourth quarter shareholder letter, you stated, “The shift to indexing had been a
headwind for the Funds for several years because it drove stocks to move in lockstep and
favored momentum investing, as indexing is a strategy that buys more of what has been going
up. Even though indexing remains in favor, 2016, and the second half of the year in particular,
saw positive signs that this force is abating. Correlations between stocks have declined, and
the market began to weigh company-specific factors more, which rewards our skills as
business appraisers.” How do you measure the abatement of the effect of indexing, and what
might make one believe this is a sustainable trend?
I don’t have a lot to add beyond what we said in the letter. Certainly, stock correlations are one
measure, and that’s a quantifiable measure of how much companies move together. Another one is
the relative results of actual stock pickers – and we fall into that category – versus both the index and
some that are more closet indexers that have much lower active shares than our high 90s active share.
To your question about this being a sustainable trend, I go back to the fact that the market is a voting
machine in the short run, but it’s a weighing machine in the long run. Like other trends that get carried
along on their own momentum in the short run, it’s often very hard to say exactly when things will
reverse. But value has a very, very long-term history of winning out in the end. Usually, when the
market or anything else reaches the point where it seems like something will keep going on forever,
that’s when it’s pretty close to peaking.
Turning to some of your specific holdings, what is the margin of safety in Alphabet?
We think it’s still significant. We bought the company when it was at one of its more hated points about
two years ago, and we were able to pay a very good price for it. Certainly, the margin of safety is not as
significant as it was then, but the value has grown strongly since, so we’re still excited to hold it.
We look at it through our usual “Business, People and Price” framework. On the business, margin of
safety can come from some of the non-earning and under-earning parts of this company. It has
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YouTube and the growing cloud business, which are probably not yet at their long-run margins.
Additionally, it has driverless cars and some of the “Other Bets,” as Alphabet calls them, which are at
an even earlier stage and experiencing losses. We value all those businesses very conservatively, and
we do not give credit for continued high-growth rates like they’ve been printing so far.
We also think that the people side of Alphabet has gotten even better since we invested. They have
brought more capital and cost discipline. CFO Ruth Porat deserves some level of credit for that, and
Larry Page and Sergey Brin, also, for bringing her in. They repurchased their own shares, which
people thought that they would never do. So they’re buying in discounted shares, which we love. And
they’ve continued to not do any big, bad deals, which can be tempting from time-to-time in the tech
world.
The final thing to talk about is on the price front. Alphabet has such a great balance sheet that further
gives cushion if things go wrong. Then we also apply a minority or control discount for the multi-share
class structure, when in actuality, the track record of these people would deserve a premium, not a
discount.
What is Wynn Resorts doing that other casino companies are not?
One big, clear differentiator would be Steve Wynn’s track record and owner/operator mindset. Steve
has a 40-plus-year history of building value per share. He is a large owner. He increased his ownership
over the last year or so by buying over $100 million worth of stock personally. That’s a great, big vote of
confidence. We love to see that.
On the business side of Wynn versus others, it has a uniquely high level of currently non-earning or
under-earning assets that will be coming online over the next several years. Its Wynn Palace property
in Macau opened up last year and is ramping nicely, versus a lot of doubters who thought it would take
longer. The company also has a project in Boston. Construction has begun there, and it will hopefully
open in 2019. But to people just looking at the company on a current cash flow basis, there’s zero
credit for Boston.
A similar type asset that will come online later is the land in Las Vegas, where Wynn has a golf course
that is currently underutilized, and the company is drawing up plans as we speak to turn that into a
cash flow-generating asset. One other thing that we applaud: The company sold about half of its retail
assets in Las Vegas at a very big multiple, versus what the stock market was giving it. That is another
example of doing the right thing, and we’re happy to be partnered with Wynn.
A question that’s rarely asked of managers is why they sold the position they favored for a
long time. I believe that Vail, in the Small-cap Fund, and Aon, in the Large-cap Fund, would be
such positions for Longleaf. What occasioned the decisions to sell them?
This is usually a function of price reaching, and sometimes even exceeding, our value. The more
history we have with a company and the stronger its business and people, the higher the price to value
ratio (P/V) at which we are willing to sell it.
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With Vail, we applaud CEO Rob Katz for growing the value per share strongly over our five-plus-year
holding period. He successfully consolidated Park City, grew the season-pass business, which reduced
a lot of volatility in the business, and made numerous beneficial decisions for which we’re grateful. But,
last year when the stock exceeded our appraisal after Vail announced that it was buying Whistler, we
felt it was time to move on.
Over at Aon, which we owned for the most part of almost 15 years – we sold it once and bought it back
– CEO Greg Case also had a good track record of growing the value strongly. But, again, when the
price reached our appraisal, and the hard-to-quantify upside of the healthcare exchange business
became a little less clear, we decided to sell.
We wish the best for both of those management teams and know that they’ll continue to do well, but
we did not feel that the margin of safety was there to continue holding the stocks.
Southeastern is known for engaging with the management and board members of the
companies in which it invests. Have there been recent examples where this has helped
formulate your investment theses?
We are constantly engaged with all of our investees and prefer to get things done behind closed doors,
but I’ll give you two more public examples: one that has been a clear winner for our international and
global accounts, and another that has been a domestic under-performer in the market to this point, but
we feel it could be a winner in the years to come.
The international winner is adidas. We knew that it had a good deal of latent brand and margin power
when we invested in 2014. Nassef Sawiris is a great businessman, who we got to know when we first
invested in Texas Industries which was a Small-Cap Fund investment years ago. Sawiris went on the
board of adidas at our urging.. By engaging with the board and management, we saw faster margin
improvement. Management also bought back shares at discounted prices. They have been monetizing
non-core assets and focusing on improving the U.S. business. The company also got a great new
CEO, Kasper Rorsted, in place. That one was a very happy outcome.
CONSOL Energy is the other one I’d like to talk about. We thought it likely that this company was going
to split its coal and gas businesses one way or another, but after a lack of speedy execution, we filed a
13D and worked with the company in a friendly manner to improve its board. A majority of the board
has turned over since we invested, and we are especially grateful that Will Thorndike is on the case as
chairman. The company has sped up its monetization efforts. Last year it sold some non-core mining
assets for what we thought were good prices, and the stock was rewarded for that in 2016. We think
there is even more to come, and the company will finally be able to split its coal and gas businesses
this year.
I know that as a value manager you don’t focus on the macro issues, but there are a couple of
macro questions on which I want to get some input. One is how do you handicap the risk that
the new administration might engage in policies that hinder world trade? What, if anything,
are you doing to adjust your portfolios for such a risk?
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You’ve probably heard the familiar refrain from us that we’re stock pickers and not macro experts, but
that doesn’t mean we want to keep our heads in the sand on the macro; it means that macro factors
can result in different things to different companies that we invest in or are considering investing in.
Some of our companies are exporters, like United Technologies, and could benefit. Some that might be
more dependent on world trade, like FedEx, might not, but there are certainly parts of FedEx, such as
their domestic ground business where world trade would probably be less of a factor. Our overall net
exposure is not tilted dramatically one way or another when it comes to trade. It’s just too soon to know
exactly how the policies will work out.
We have a large position in cash, approximately 15% to 20% across our portfolios, and are ready to
deploy it intelligently should we get some volatility with one side of this debate becoming more hated
than the other.
Have any other aspects of the new administration, including what some consider to be a
degree of unpredictability, caused you to rethink your investment strategy or your outlook for
your funds?
If we looked back over Southeastern’s 40-plus-year history, there have been a lot of unpredictable
events. Bond rates in the high teens in the early 1980s; Black Monday, the Berlin wall coming down,
Asian crises in the late 1990s; the tech bubble, 9-11 and the global financial crisis last decade; and the
Eurozone crisis in the early part of this decade. Last year, we had Brexit and the election of President
Trump.
Through all of that and going forward, we remain focused on Business, People, and Price for our
existing investments and potential new ones. Like I mentioned, we have more cash today than usual.
That is somewhat of a contrarian view with bulls outnumbering bears at near an all-time high, based on
data from some of the services we track. The volatility index is also at a pretty low level.
But our cash holding is not a top-down macro call. It’s driven by sales of some investments that have
reached their appraisal. Continuing to have that cash position of strength will allow us to invest in great,
new companies if global uncertainty gives us that opportunity.
On the subject of unpredictability, when you partner with great management teams that have the ability
to go on offense, unpredictability is your friend. Times like that are when you can sow the seeds for
long-term value growth.
We welcome unpredictability, and we are doing our best to be prepared.
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